A Report from the Economist Intelligence Unit

A report from The Economist Intelligence Unit

Sponsored by: A crisis of culture Valuing ethics and knowledge in financial services

Contents

About the report 2

Executive summary 3

Introduction: In search of culture 5

Case study: Rebranding Goldman Sachs 8

Chapter 1: Ethics in the firm 9

Case study: Changing tracks at UBS 12

Chapter 2: Safety in knowledge 13

Chapter 3: Reincorporating culture 15

Case study: Keeping it simple 17

Conclusion 18

Appendix: Survey results 19

1 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

About the report

A crisis of culture: Valuing ethics and knowledge in financial l Michel Derobert, general secretary, Swiss Private services is an Economist Intelligence Unit (EIU) report, Bankers’ Association sponsored by CFA Institute. It examines the role of integrity l Bob Gach, managing director, Capital Markets, Accenture and knowledge in restoring culture in the financial services industry and in building a more resilient industry. The report l Steven Münchenberg, chief executive officer, Australian draws on three main sources for its research and findings: Bankers’ Association l A global survey of 382 financial services executives l Robert Potter, chairman, City HR Association conducted in September 2013. Of these, 42% are based in l Ulf Riese, finance director, Handelsbanken Europe, 34% are based in Asia-Pacific, and 20% are based in North America. One-half are C-suite executives, and the rest l Hiba Sameem, researcher, The Work Foundation are senior executives and managers. Nearly one-fifth (18%) l Richard Sermon, chairman, City Values Forum are executives from asset management firms, 16% are from l Jacques de Saussure, senior partner, Pictet commercial banks, 15% are from retail banks, 12% are from insurance and reinsurance firms, 11% are from private banks, l Jon Terry, global head, HR Consulting Practice, PwC 11% are from fund management firms, 9% are from investment l Andre Spicer, professor of organisational behaviour, Cass banks, and 8% are from wealth management firms. Business School l A global survey of 50 executives from firms supporting the l Gert Wehinger, senior economist, Financial Affairs financial services industry across a number of areas, including Division, OECD Directorate for Financial and Enterprise technology, marketing and business processes. Affairs l A series of in-depth interviews with senior financial industry l Martin Wheatley, chief executive officer, Financial executives and experts: Conduct Authority l Juan Ignacio Apoita, global HR director, BBVA We would like to thank all interviewees and survey respondents l Peter Cheese, chief executive officer, Chartered Institute for their time and insight. The report was written by Michael of Personnel and Development Kapoor and edited by Sara Mosavi. l Prasad Chintamaneni, global head of banking and financial services, Cognizant l E. Gerald Corrigan, managing director, Goldman Sachs

2 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

Executive summary

Back in 1980, just 9% of Harvard MBAs went role that greater knowledge plays in building a into financial services. By 2008, the figure was stronger culture within financial services firms. up to 45%. Lured to Wall Street and the City by generous pay packages, financiers were The main findings are as follows. encouraged to chase rapid earnings growth. l Most firms have attempted to improve Short-term profit priorities led to extreme adherence to ethical standards. Global risk-taking at many firms, with employees institutions, from Barclays to Goldman Sachs, selling complex derivative products they did not have launched high-profile programmes that understand (and that many of their corporate emphasise client care and ethical behaviour. Our clients did not need), and lending to people who survey supports the anecdotal evidence, with could not afford the repayments. nearly all of the firms represented in the survey having taken steps to improve adherence to Since the global financial crisis of 2008, the ethical standards. Over two-thirds (67%) of firms question being asked about the industry is represented in the survey have raised awareness whether it can change, shifting its culture to of the importance of ethical conduct over the become more risk-averse and client-centric. last three years, and 63% have strengthened There is little doubt that strengthening culture, their formal code of conduct and the system including the promotion of ethical conduct for evaluating employee behaviour (61%). Over and greater knowledge, is a priority for the top two-fifths (43%) of respondents say their firms echelons in the financial services industry. In have introduced career or financial incentives to recent years many firms have launched thorough encourage adherence to ethical standards. reviews of their practices as part of their efforts to decide who they are, what they do, and how l Industry executives champion the they should do it. But it could take years before importance of ethical conduct... Despite a spate change is seen at all levels of the organisation. of post-crisis scandals that suggest continued profit-chasing behaviour, large majorities agree In A crisis of culture we examine the global that ethical conduct is just as important as financial services industry’s record on ethical financial success at their firm. Respondents would conduct; we investigate the level of knowledge also prefer to work for a firm that has a good financial services executives have of their own reputation for ethical conduct than for a bigger firm and of their industry; and we explore the or more profitable firm with questionable ethical

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standards. Nearly three-fifths (59%) personally making their firm more resilient to risk. Three- view the industry’s reputation on ethical conduct fifths think gaps in employees’ knowledge pose a positively; and 71% think their firm’s reputation significant risk to their firm. outperforms the industry’s. Executives may have confidence in the effectiveness of current efforts l Nonetheless, a lack of understanding to improve adherence to ethical standards, but and communication between departments consumers remain unconvinced. The industry was continues to be the norm. Many argue that voted the least trusted by the general public in ignorance was a key contributor to the global the 2013 Edelman Trust Barometer. financial crisis: managers signed off complex products they did not understand, while HR l …but executives struggle to see the benefits departments agreed to incentives they did not of greater adherence to ethical standards. realise encouraged risk-taking. Five years after While respondents admit that an improvement in the crisis not much seems to have changed: 62% employees’ ethical conduct would improve their say that most employees do not know what is firm’s resilience to unexpected and dramatic happening in other departments. Over one-half risk, 53% think that career progression at their (52%) also say that learning about the role and firm would be difficult without being flexible performance of other departments would be the on ethical standards. The same proportion least helpful to improving their performance. thinks their firm would be less competitive as a consequence of being too rigid in this area. Less Senior executives need to ask whether the than two-fifths (37%) think their firm’s financials power to influence at their firm is shared widely would improve as a result of an improvement in enough. The ultimate question for financial the ethical conduct of employees at their firm. It services firms is: who is, or who should be, in seems that, despite the efforts made by firms in charge—the bankers, the traders, or those recent years, ethical conduct is yet to become a support departments that keep risks in check, norm in the financial services industry. such as human resources, compliance and risk? The challenge for firms is to form enduring l To become more resilient, financial services partnerships between functions to ensure that The firms need to address knowledge gaps. the firm is run by experts in everything it does. increasingly complex risk environment has A number of firms, including ones interviewed made advancing and updating knowledge of the for this report, are already bringing together industry crucial for those working in or serving different functions to vet big, important the financial services industry. Nearly three- decisions concerning the firm’s future and to fifths (59%) of respondents identify better ensure a coherent culture and approach to risk. knowledge of the industry as the top priority for

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Introduction

In search of culture and financial institutions fixated on return on equity—encouraging them both to chase revenue In many cases and to keep capital levels modest to increase Pre-tax profits at the world’s 1,000 largest banks there is no profitability. In the short term, the effects were surged by almost 150% between 2000-01 and dramatic. But the focus on boosting profits such a thing 2007-08, according to the magazine The Banker, rapidly was not sustainable, and eventually led to as a single as firms borrowed heavily to boost profits.1 a global financial crisis in 2008. culture within Financiers also devised new techniques, such as securitisation, that allowed lenders to sign Financial services firms are working hard to a bank apparently lucrative deals and then sell on the change the pre-crisis culture. But for change risk. Martin Wheatley, the chief executive of to permeate throughout the firm could Andre Spicer, professor of the Financial Conduct Authority (FCA), the UK’s take years, if not decades. In fact, since the organisational behaviour, industry regulator, sums up the problems that fed crisis emerged, there have been a number of Cass Business School the crisis as a collision between financial services scandals in the financial services industry. For employers incentivised to increase sales volumes instance, Europe’s biggest bank, HSBC, paid

Table 1: Top ten bank fines Fine Bank US$1.9bn HSBC, money-laundering lapses US$1.5bn UBS, Libor-rigging US$920m JPMorgan, trading scandal US$780m UBS, aiding tax fraud US$667m Standard Chartered, breaching sanctions US$619m ING, breaching sanctions US$612m RBS, Libor manipulation US$550m Goldman, misleading investors US$536m Credit Suisse, breaching sanctions 1 “The Future of Finance: The US$500m ABN Amro, breaching sanctions LSE Report”, A. Turner et al, US$451m Barclays, Libor manipulation London School of Economics Source: The Telegraph, September 19th 2013. and Political Science, 2010.

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penalties worth a total of US$4.2bn in 2012, “In many cases there is no such thing as a split between US$2.3bn in compensation for single culture within a big bank,” says Andre mis-selling financial products in the UK and Spicer, professor of organisational behaviour at a US$1.9bn fine for lax money-laundering London’s Cass Business School. “Often entire controls in the US. Senator Carl Levin, the teams were lifted from outside institutions as chair of the US Senate Homeland Security and a bank expanded into new areas, especially in Governmental Affairs’ Permanent Subcommittee investment banking. This is not just a question of 2 “HSBC exposed US on Investigations, described HSBC’s compliance the split between investment and retail banking financial services to culture as “pervasively polluted”, which had ethics and culture. It’s that institutions operate money laundering, drug, exposed the US financial system to “a wide as a bunch of separate silos, each one with their terrorist financing risks”, Permanent Subcommittee array of money-laundering, drug trafficking and own different cultures and operating practices.” 2 on Investigations, US terrorist financing risks.” HSBC’s experience is Homeland Security and a sobering reminder that avoiding a repeat of the Like many other banks, from its compatriot RBS Governmental Affairs, July crisis is not a simple or quick task. to BBVA in Spain, Barclays bought into new 2012. geographical markets as well, paying handsomely 3 The London Inter-bank Lost identities to buy a big presence in countries from South Offered Rate (Libor), a benchmark interest rate, Much of the criticism directed at the financial Africa to the US. The result, as condemned by is calculated using a services industry has centred on culture. The the Salz Review, was a bank that was too big to “trimmed” average of rates wave of mergers and acquisitions (M&A) that manage and a complex corporate culture that submitted by individual swept the industry before the crisis left behind made controlling risks problematic. banks at 11 am London time a number of convoluted firms. Barclays, for based on their perceived instance, bought its way into investment banking “The dilution of bank culture, and the leaching of unsecured borrowing costs. Allegations surfaced in through a series of acquisitions. In 1986 it aggressive investment banking values into more 2012 that a number of large bought De Zoete & Bevan and Wedd Durlacher conservative fields such as retail can be traced banks had manipulated to merge with Barclays Merchant Bank to form right back to Big Bang,5 and wider financial their rate submissions to BZW. In 1996 BZW was merged with another services liberalisation around the world in the boost profits. acquisition, Wells Fargo Nikko Investment 1980s and 1990s,” says Mr Spicer, in comments Advisors, to form Barclays Global Investors. broadly echoed by many of our interviewees. 4 Salz Review: An Independent Review of And in 2008 Barclays expanded its presence in Barclays’ Business Practices, global investment banking by buying the North How the other half bank A. Salz, April 2013. American assets of the collapsed US household Emerging markets were only lightly hit by the name Lehman Brothers. 5 The Big Bang was a period banking crisis. Now, however, fears are mounting of deregulation for the UK’s When the Libor-rigging scandal broke in that Asia, in particular, could face systemic securities market starting in 2012,3 the board of Barclays commissioned problems as its banks develop and grow more October 1986. As part of it an independent external review of the bank’s aggressive. In October 2013 the rating agency the London Stock Exchange business practices, headed by Anthony Salz. Standard & Poor’s (S&P) warned in a statement was privatised, which led that “a regional banking crisis isn’t out of the to a number of changes, The review said: “We believe that the business 6 including automation of practices for which Barclays has rightly question.” In particular, it worries that slower trading and firms being been criticised were shaped predominantly economic growth could lead to a rise in bad debts allowed to operate in a dual by its cultures, which rested on uncertain in both China and India, with China’s unregulated capacity, as both brokers foundations.” As a result, the review called for shadow banking sector a particular concern. and dealers. “transformational change”. “There was no sense “Years of very rapid credit expansion ... along with a strong increase in housing prices, is set to 6 “Don’t rule out an Asia of common purpose in a group that had grown banking crisis, S&P says”, E. and diversified significantly in less than two backfire on banks’ asset quality, profitability and Curran, Wall Street Journal, decades,” concluded the review.4 possibly liquidity,” the agency warns. October 2013.

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So far, tight state regulation has avoided the comprehensive review of their culture and excesses of banks in developed markets in places practices, often emphasising the need to like China and India. To avoid future problems, prioritise customer service over short-term they should perhaps look at the example of profits. These are thorough-going exercises as Australia, which weathered the global crisis financiers spend time and money on deciding successfully after tightening regulation massively who they are, what they do, and how they should following a big scare in the 1990s.7 do it.

Steven Münchenberg, the chief executive of the How far such thinking has filtered down the Australian Bankers’ Association, points to two ranks of financial services workers remains open things that prevented the collapse of any major to question. A recent survey by the Financial Australian bank during the crisis. The first was Services Authority, the former UK regulator, the very tight regulation after the problems of found that junior retail banking staff were still the 1990s, which meant that “regulators were incentivised to sell maximum volumes, rather crawling all over our banks”, preventing too than to make risk-return calculations.9 “And much risk-taking. The second was the fact that this isn’t a question of the big earners,” says

7 Australia went through banks, the government and the regulators were Mr Wheatley, “but of people earning a modest a period of deregulation able to talk openly and trustingly about what amount, say £20,000 a year and chasing another in the mid-1980s, which was happening during the global financial crisis. £5,000 in bonus payments.” increased competition Another factor, as explained in 2009 by Ian between financial services MacFarlane, a former governor of the Reserve As Robert Potter, the chairman of the City firms as they chased rapid Bank of Australia, was the effective bar on the HR Association in the UK points out, reform balance-sheet growth. in the financial services industry ultimately Deregulation led to strong four big Australian banks merging or being taken means “hiring a different sort of person”, quite credit growth secured over by each other, which prevented the mass against increasingly of mergers and acquisitions that so diluted the apart from a deep reorganisation. Changing overvalued assets. As culture of banks in Europe and the US.8 Australian behaviour means ensuring that all staff members interest rates rose and banks still made mistakes (including buying US understand the broader picture of banking and commercial property values mortgage derivatives). But they did not make ethics, as well as their immediate roles. And this fell in 1989, the risky nature needs to start in the top echelons of the industry, of the loans that had been them on a scale that might have led to their where culture often comes from. paid out became evident. collapse. The Australian financial services industry saw In the next two chapters we explore two of the individual losses exceeding Time to change building blocks of culture in financial services: AUS$9bn between 1990 At a top management level, banks from ethics and knowledge. and 1992. The Australian Barclays to Goldman Sachs have launched a Financial System in the 1990s, M. Gyzicky and P. Lowe, Reserve Bank of Australia, 2000.

8 “Four Pillars policy our shield against crisis”, J. Durie, and R. Gluyas, The Australian, March 2009.

9 “Guide Consultation: Risks to customers from financial incentives”, Financial Services Authority, September 2012.

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Rebranding Goldman Sachs

“It was a wake-up call,” says E. Gerald Corrigan, But the review also highlighted some of the managing director at Goldman Sachs, when tensions faced by big investment banks such describing the US$550m fine the firm was as Goldman Sachs. Alongside a commitment issued by the Securities and Exchange to prioritise customer service and behave Commission (SEC) in 2010 for misleading ethically, the bank still lists the commitment investors about a product tied to subprime to maximise shareholder returns, for example. mortgages. “The reputational damage required A 2011 survey of 200 of the bank’s biggest great attention which we attempted to address clients found that some of them thought it through the Business Standards Committee placed its short-term interests above those of report (BCS).”10 its clients. Some clients also thought the bank’s involvement in proprietary trading actually put Goldman’s reaction to the SEC fine was to launch it in conflict with its own customers. As a stock a fundamental review of its business practices exchange-listed company it has little choice and culture, which US firms are required over this, but the tension between maximising to publish. Many people blame the shift in short-term performance and maintaining a Goldman’s culture on two things. First, after the partnership’s long-term view remains. bank moved away from its partnership status in favour of a stock exchange listing in 1999, it There is little doubt that the review is a sincere encouraged a more short-term, profit-centred effort at change, with senior managers going approach. And second, its 1990s decision to on compulsory courses to make them think grow in size to avoid being overshadowed by the about the ethics and big decisions, including likes of JP Morgan. That led to a number of deals involvement in any deals worth more than marked by conflicts of interest: for example, US$850m, now vetted by a committee including in its work on private equity deals Goldman functions such as HR and risk, as well as the advised both the buyer and the target company. heads of the various business units. Mr Corrigan acknowledges the desire to return to something The effort going into the review was akin to the old, long-term focused partnership extraordinary, says Mr Corrigan, consuming model (pointing to the risk committee in between one-third and one-half of the time support). But how long it will take to mend the of the firm’s 400 partners over a three-year damage done to Goldman’s reputation remains stretch. The result of the BCS was a set of 39 open to question. recommendations, published in 2011.

10 “Goldman Sachs to pay record $550 million to settle SEC charges related to subprime mortgage CDO”, US Securities and Exchange Committee, July 2010.

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1 Ethics in the firm

Chart 1 of dollars and the effective collapse of many institutions during and since the crisis (see chart Which of the following would benefit the most by an 1). improvement in the ethical conduct of employees at your firm? (% of respondents) Ethical conduct might still not be an entirely natural fit with financial services, where over Firm's ability to withstand unexpected and dramatic risks 56% one-half (53%) say that career progression would be tricky without being “flexible” over ethical Firm's revenue and standards; this rises to close to three-quarters market share 30% (71%) of investment bankers taking the survey. Firm's profitability 7% Across regions, North American and Asia- Pacific respondents tend to agree, while 52% of There would be no benefit 3% Europeans counter the claim. Rigid adherence to ethical standards would also damage the firm’s competitiveness, say 53% of respondents. Other 3%

Note: percentages were rounded up and may not add up to 100%. Bringing out the best Source: The Economist Intelligence Unit. Although there is tension between the importance of ethical conduct to financial Financial services executives appear to recognise services executives and the barriers ethical the importance of ethical behaviour. Nearly all standards can create for career advancement (91%) of the respondents to our survey say that and competitiveness, financial firms have been ethical conduct is just as important as financial trying to work on restoring integrity in recent success at their firm. A similar proportion (96%) years. Less than 1% say that their employers have say that they would prefer to work for a firm with done nothing to improve adherence to ethical a decent reputation for ethical conduct. The great standards over the past three years. Just over majority (91%) also agree that aspiring to a set two-thirds (67%) say that their firms have made of globally recognised standards would make the staff more aware of the importance of ethical industry more resilient. conduct over that time, and more than two-fifths There is a weaker consensus among executives have introduced or strengthened ethical codes on the benefits of adhering to a code of ethical (63%) and the system for evaluating conduct conduct. Over one-half (56%) say that stronger (61%) (see chart 2). adherence to an ethical code of conduct would improve their companies’ ability to withstand More than two-fifths (43%) of respondents’ firms unexpected shocks. But just 37% of respondents have introduced financial or career incentives think that better ethics would mean better for respecting the ethical code of conduct, to financial results, despite fines totalling billions counter criticisms that bankers have become

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Chart 2 for adhering to ethical standards, compared with one-third from retail banking. Noticeably, only What steps, if any, has your firm taken over the last three years 37% from Europe have been given financial or to improve employees' adherence to ethical standards across career incentives to be ethical, compared with the firm? Select all that apply 50% in Asia-Pacific and 43% in North America. (% of respondents) The use of such an instrument does raise Raised awareness of the questions about how much banks have changed importance of ethical conduct 67% by all employees their ways. If pay packages since the crisis have Introduced or strengthened a become more closely aligned with encouraging formal code for ethical conduct 63% a risk-averse culture and ethical conduct among Introduced or strengthened the financial services employees, then that could system for evaluating employee 61% go some way towards making the industry as a conduct whole safer. However, it does beg the question Introduced financial or career incentives 43% of whether the use of incentives means that financial services executives have a tendency Other 1% to flout codes of ethical conduct, and whether My firm has taken no steps to ethical conduct will ever become a norm among improve adherence to ethical 1% financiers rather than a goal. standards

Source: The Economist Intelligence Unit. Happy-go-lucky or simply deluded? The jury may still be out on whether the financial more motivated by incentives than good conduct. services industry has seen real change. But the Again, the proportion increases as you go up the industry’s confidence does not waver when it risk—and confidence—ladder, and well over half comes to its record on ethical conduct. Perhaps (56%) of investment bankers can get a reward as a result of the action firms are taking, nearly

Chart 3 Chart 4 Rate the financial services industry’s In your personal view, how does your current reputation for ethical conduct firm’s current reputation for ethical in your personal view conduct compare with the rest of your (% respondents) industry? (% respondents) 3% Worse

14% Negative 26% About the same 27% 59% Neutral Positive Be71%tter

Source: The Economist Intelligence Unit. Source: The Economist Intelligence Unit.

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three-fifths of the executives surveyed (59%) say reputation stands in stark contrast to the 2013 that the financial services industry has a strong Edelman Trust Barometer, an annual survey of reputation on ethical conduct (see chart 3). And global consumer sentiment which found that three-quarters (71%) say that their firm has an financial services was the least trusted of all even better reputation than the industry norm industries, ranking well below technology, the (see chart 4). automotive sector, telecommunications and the media. Only 46% of Edelman’s respondents The contrast in attitude between different sectors trusted financial service providers to do the right of the industry and regions stands out. Less than thing; the proportion was higher (61%) among one-half (49%) of asset managers reckon the respondents in Asia-Pacific, but lower (29%) in industry has a positive reputation, as against the EU (see chart 5). Nearly two-fifths (59%) 70% of investment bankers. Europeans come of respondents familiar with the banking and across as quite uncomfortable too. Only 31% say financial services scandals say that “the biggest they have a good reputation on ethical conduct cause” was internal factors, such as a bonus- among external stakeholders—a much lower driven corporate culture, conflicts of interest and proportion compared with 53% from Asia-Pacific corporate corruption.11 Financial services workers and 51% from North America. are more confident that the problems have been 11 Edelman Trust Barometer, solved than their customers, it seems. January 2013. Investment bankers’ confident opinion of their

Chart 5 Financial services industry is the least trusted to do the right thing by general public (% of respondents)

73% 70% 66% 62% 62% 62% 61% 61% 60% 60% 57% 57% 55%

in g 54% 51% 50% 49% 46% s anie s mp e in g it s ry ainmen t s maceuticals rt ing & spir ew Chemicals Medi a Bank Fi nancial se rv ices chnology Te manufactur electronics Consumer Automotive beverage & Food defens & Aerospace Ente Phar Energy Consumer health co Br Metals indust Food manufactur lecommunication s Te good packaged Consumer

Source: Edelman Trust Barometer, 2013.

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Changing tracks at UBS

It all seemed such a sound idea back in 1998, to outside investment funds and some to the when Union Bank of Switzerland merged with Swiss government (which subsequently sold Swiss Bank Corporation (SBC) to form UBS, a on a convertible bond issue for a profit). Some new giant of Swiss banking that dominated the of UBS’s reactions have been predictable, for local retail market as well as global investment example, slashing its investment banking arm banking and wealth management. Why, by around two-thirds and banning activities then, did things go so badly wrong with this such as proprietary trading. However, its moves powerhouse in the crisis? And what can be done post-crisis amount to a deep rethinking, and to sort out the mess left by a flawed giant that not just to cutting out the bad bits. needed a big helping hand from the Swiss state? Simply put, UBS has redefined itself around The simple answer is that investment banking wealth management and introduced structures was allowed to dominate group activity, which to ensure that its various divisions, from wealth led to massive losses: UBS was a heavy buyer of and asset management to retail and investment US sub-prime mortgage-backed assets, leading banking, work together for its clients’ to losses totalling US$50bn during the crisis. benefit rather than operating as separate Many blame the investment banking problems silos. Investment banking is still regarded on a clash of cultures between the two merged as necessary, providing a source of detailed banks, both of which had bought their way into research and product development. But its role investment banking before 1998. has been cut back to those activities that feed the other areas. In 1995 SBC had bought one of the largest London investment banks, SG Warburg, and in Almost more strikingly, there has been a much 1997 a similar institution on Wall Street, Dillon wider reassessment as the bank rediscovers Read, to become one of the biggest dealmakers its wealth-management mandate. Wealth in the world. That was a bad fit with Union Bank managers and even retail staff have been of Switzerland’s acquisition in 1986 of Phillips retrained to focus on advisory services, rather and Drew, a relatively conservative London than on selling products. Even the Swiss retail stockbroker, wealth manager and hedge fund, network has been revamped, as UBS accepts along with similar firms in Germany and the US. both that its home market remains core and its buildings had become a little old-fashioned for The two very different cultures on the modern tastes. investment banking side never truly merged, feeding bad decision-making. In 2007 UBS It is a thorough and ongoing exercise, and was the first bank to announce losses from the there are signs that UBS is mending some of the US sub-prime mortgage crisis. It had set up damage to its reputation. As well as improved an internal hedge fund through its subsidiary financial results, it announced in July 2013 Dillon Read, which invested its own and that it had regained its title as the biggest clients’ money in complex mortgage derivative wealth manager in the world, growing assets products. That fed UBS losses of US$17bn in by 9.7% to US$1.7trn.12 It is a sign that trust is 2008, the largest in Swiss corporate history. returning. But UBS remains not only a powerful 12 “UBS Leapfrogs Bank example of the damage wrought by pre-crisis of America to Top Wealth As the losses mounted, UBS was forced into a risk-taking, but also a rare example of a Swiss Manager Rank”, G. Broom, series of capital-raising measures, some sold private bank that lost its way. Bloomberg, July 2013.

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2 Safety in knowledge

Although nearly all (97%) respondents are regional and national, regulation of the finance confident that they are well qualified for their industry. job, our survey finds a tendency for financiers to specialise. When asked how they could perform These findings must give rise to concern, better in their job, two-thirds say that learning considering the litany of complaints of how ignorance drove the financial crisis. Managers signed off on Chart 6 complex investment Are you confident in your knowledge of the following: products they did (% of respondents) not understand. HR departments waved Competitive landscape Regulatory environment for my firm for the financial through pay packages services industry that they did not realise were structured to In the country 88% I am located 89% encourage risk-taking.

In the region Respondents to our 45% I am located 41% survey agree that knowledge gaps, such 14% In the world 12% as not knowing what other departments are Source: The Economist Intelligence Unit. up to, can increase risk levels: six out of ten respondents say that their firm faces a serious about issues directly affecting their role would threat from gaps in employees’ knowledge. Nearly be most helpful. However, learning about other three-fifths (59%) of respondents accept that departments in the firm would be the least better industry knowledge is crucial to making helpful activity. In fact, over three-fifths (62%) their firm more resilient to risk, and essential report that their colleagues know very little of to understanding an increasingly complex risk what is happening in outside departments. environment. Closing knowledge gaps among 13 “More cuts to take UK financial services executives could make the And while they may be confident in the financial job losses to industry as a whole safer. 132,000”, M. Clinch, CNBC, competitive and regulatory environment in their January 2013. own country, their confidence drops significantly when asked about their region and conditions Losing control? 14 “Financial sector job cuts around the world (see chart 6). This is despite Efforts to improve knowledge among financial announced: 200,000”, S. the much-discussed globalisation of financial services employees can be challenging. Dramatic Hyman, Bloomberg, January 2012. services and attempts at global, as well as cost-cutting since the onset of the global

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Chart 7 his own firm’s survival of the crisis in part to its development of very sophisticated systems Top five reasons to improve knowledge of the financial services industry in-house. In other words, if processes such as (% of respondents) credit vetting are being increasingly automated Increasingly complex risk and outsourced, the parent bank had better environment 50% keep a very close eye on both the risks it is Increasing role of technology running and on how those decisions are being and automation in finance 42% made. According to 42% of financial services executives, the increasing role of technology Globalisation of financial services 39% and automation has made updating knowledge of their industry crucial (see chart 7). Specialisation of job skills 31% Bob Gach, Accenture’s head of capital markets, Customer dissatisfaction 25% makes the argument that big firms like his own can develop a depth of expertise in the areas Source: The Economist Intelligence Unit. they cover and develop the systems to make sure that financial services firms obey, for example, financial crisis has seen hundreds of thousands risk parameters strictly. “But it’s for the bank in the sector lose their job: since the fourth to manage its business, set its risk appetite If you’re going quarter of 2008, 132,000 jobs have been lost in and oversee its client service,” he says. Prasad 13 to outsource, the UK, and 380,000 in the US. In 2011 more Chintamaneni, the global head of banking and you need to be than 200,000 job cuts were announced in the financial services at Cognizant, an IT services and financial services industry globally, with most consulting firm says that financial services firms darned sure 14 of them taking place in 2012 and 2013. As are implementing significant technology and the company firms shed employees, they rely more heavily on process changes to evolve a more holistic view of knows what outsourcing partners to carry out processes that a bank’s global risk across its entire operations. it’s doing were previously handled internally. That places “Clients, counterparties and investors simply a heavier burden on remaining staff to control didn’t realise the level of risk exposure Lehman the activities of outside companies on which they had through over-leverage,” he says of the US E. Gerald Corrigan, managing increasingly rely. investment bank that collapsed in 2008. “The director, Goldman Sachs current risk-related regulatory compliance As part of the research conducted for this report, initiatives and the overhaul of risk management the EIU surveyed executives working in firms that applications and processes at banking and support the financial services industry, ranging financial institutions endeavour to mitigate any from business processes outsourcing companies recurrence of Lehman-like market crises.” to legal firms. Remarkably, opinion among these respondents was split exactly in half on Realistically, with claimed cost savings of up whether employees have a basic understanding to 50% on offer for some back-office services, of the financial services industry. Only 28% according to Mr Gach, financial companies will report a good or excellent level of knowledge of continue to use outsourcing more heavily as the industry, and just 24% say employees have tighter regulation makes capital, and cash, a good grasp of the regulations affecting the harder to find. Big banks have been looking at financial services industry. it for many years with increasing numbers of mid-sized institutions taking a closer look more “If you’re going to outsource, you need to be recently. darned sure the company knows what it’s doing,” says Mr Corrigan of Goldman Sachs, who credits

14 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

3 Reincorporating culture

Once firms list on a stock exchange, they tend Pictet has managed to continue expanding since to focus on short-term results, driven in part by then, using its core private banking skills to quarterly reporting requirements and in part expand its presence in asset management. Like by the proliferation of short-term investors. many of the Swiss private banks, it remains a In the years leading up to the global financial partnership at the group level, although this has crisis many banks, encouraged by their stock become trickier as a result of regulatory changes. exchange-listed structure, pursued short-term profits, which contributed, some argue, to the In many ways, the most telling point about Pictet Partnerships severity of the 2008 meltdown. is that it was offered, and declined, the complex must take a investment products that proved unsound, In the past, however, a partnership structure was from collateralised debt obligations (CDOs, long-term view much more commonplace in the financial services the US mortgage derivatives that made wobbly by definition industry. “Partnerships must take a long-term sub-prime debt seem safe) to Bernard Madoff’s view by definition,” says Jon Terry, the global pyramid scheme that offered apparently high but head of PricewaterhouseCooper’s HR Consulting safe returns to investors. It turned them down Jon Terry, global head of Practice. “Senior staff tend to be more focused because they were not transparent enough, or PWC’s HR Consulting Practice on their longer-term success, including their own because the sums did not add up (as at least one retirement prospects, than on the short-term financial analyst told the Securities and Exchange results encouraged by listed companies’ quarterly Commission about Mr Madoff’s scheme back in reporting requirements.” 1999).

Many of the institutions that weathered the global financial meltdown either adhered to a Sharing power in financial services partnership structure, such as Pictet, a large Swiss It would be unrealistic for large multinational wealth manager, or found ways to emulate it, such banks, such as Barclays, to return to a as Goldman Sachs (which gave up its partnership partnership model. But one very concrete status when it listed on the stock exchange in question to ask in this context is who controls 1999). Others have made a long-term view an the bank: investment bankers, retail bankers or integral part of the running of the bank, such as those departments that keep risks in check, from Handelsbanken in Sweden, which does not set its human resources to compliance and risk? If such branches sales or financial targets but has grown support departments have no say over setting consistently for 40 years (see box: Keeping it policy, then risks can quickly get out of control. simple). This is an area at which many financial In Switzerland, none of the members of the institutions are looking hard, and where the Swiss Private Bankers’ Association hit trouble most convincing solution might be to bring back as a direct result of the crisis, according to the some of the practices that worked well from the association’s general secretary, Michel Derobert. partnership model. According to Mr Derobert,

15 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

the ultimate responsibility for human resources which has operated in the same way since 1970. usually lies with the bank’s senior partner. However, Spain’s BBVA does seem to prove Choosing the right people is one of the best ways that it is possible to forge a coherent entity to ensure continuity of culture. Goldman Sachs, a from a muddle of mergers, acquisitions and partnership until its stock exchange listing, has international expansion. introduced a management committee to vet big decisions, in a bid to ensure that departments “We’re a retail bank,” says Juan Ignacio Apoita, such as risk and compliance have the same say BBVA’s global HR director, “and our focus remains in decision-making as the heads of the various squarely on our retail and corporate customers.” business units. And like Goldman Sachs, BBVA has set up a management committee mixing the heads of “The real challenge is not just to ensure that specialisms such as HR and IT with the heads of non-banking staff understand finance,” says the business units to ensure a coherent culture, Peter Cheese, the chief executive of the Chartered and approach to risk, across the group. Financial Institute of Personnel and Development, “but education is taken very seriously, with the bank to ensure leaders of the business, whether home to its own university, Campus BBVA. their roles are in HR, IT, or more core banking functions, are taking genuinely shared The strategy has worked well enough for BBVA, responsibility for the purpose, culture and formed from the merger of various Spanish banks strategic direction of the business.” In other through 1999, to avoid the worst of the crisis. It words, these departments need to work in did take a hit from the collapsed Spanish property partnership together over running the bank. market and accepted funds from a Brussels-led That is a big organisational shift. It also means bail-out of the country’s banks, but it avoided that financial services staff need a much wider collapse. Mr Apoita points out that BBVA lost understanding of their employer, and the market share to more aggressive Spanish rivals industry, to juggle risks and returns effectively, during the pre-crisis property boom, suggesting and certainly to manage companies. that some sanity remained over lending policy. And since the crisis the bank has expanded successfully into the US and Latin America as Out of the chaos it grows international revenue. “We have the Cost cutting, M&A, increasing automation—none systems and the structures to ensure that foreign of these fits well with the need to foster a single subsidiaries follow bank policy,” says Mr Apoita. culture at firms. Ideal solutions are tricky to find, certainly beyond the likes of Handelsbanken,

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Keeping it simple

There are a plethora of differences between Handelsbanken’s success might take too long Handelsbanken and mainstream banks, to show in financial results for there to be any according to its CFO Ulf Riese, which taken realistic chance of a stock exchange-listed bank together mean not that it is risk-averse, but following its lead. But it does show two things. that its whole ethos is about long-term returns First, that banks can reinvent themselves: rather than short-term profits. First there is Handelsbanken introduced its present system its profit-sharing scheme, Oktogonen. If the in 1970 after several scandals broke when it bank makes a return on equity (ROE) above was operating as a normal universal bank in the the annual average of its peers, then every 1960s. And second, that a localised approach employee receives an equal share of the profit. such as this avoids many of the problems that But this is only payable at the age of 60. The blighted banks in the US and Europe. bank has beaten its ROE target for every one of the past 41 years. And an employee who has “Everything revolves around our clients,” says been in the scheme from the start can now Mr Riese, “and so if things aren’t useful to them, expect a pay-out of more than £1m. we don’t do them.” That is why it avoided the very complex derivatives products that caused “This is one of the keys to us taking a long-term such problems in the US and elsewhere. And approach,” says Mr Riese. The other is that that is why it was never tempted to use its small “the bank is the branch”. Branch managers investment banking division for proprietary are allowed a remarkable degree of autonomy, trading that would have endangered the bank having complete authority within their own itself. area over everything from marketing spend to credit decisions. That is a big contrast to many In many ways that is also the message from universal banks, which are tending to centralise Pictet. One of Switzerland’s older private to cut costs. This localised approach explains banks, it has expanded rapidly by using its many of Handelsbanken’s apparently eccentric core wealth management skills to expand its practices, from refusing to set financial and presence in asset management, continuing sales targets for branches to having no central to attract new money even after the crisis. Its marketing budget. senior partner, Jacques de Saussure, credits much of that resilience to its partnership The important point is that it has worked, structure, “which means we must have a allowing Handelsbanken to survive the global long-term outlook”. In fact, it has recently financial crisis without help, as well as Sweden’s incorporated many of its business units to own serious banking crisis in the 1990s. In satisfy new regulatory requirements, but its fact, Handelsbanken has had the world’s best- holding company remains a partnership. And, in performing shares since 1900: £10 invested an echo of Handelsbanken, it avoids aggressive then was worth £20m by 2009, with very low bonus payments for most of its staff, just as it bad debt levels and a business that has grown spurns acquisitions in favour of organic growth. 15 “Handelsbanken is impressively since the crisis. It has expanded “Taking over another company can cause championing an old way of fast in the UK, growing its network in the problems with company culture,” says Mr de doing new UK business”, country from 60 branches in 2008 to 161 in Saussure. H. Wilson, The Telegraph, 2013.15 August 2013.

17 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

Conclusion

Emerging from the global financial crisis, the financial services A number of deep-rooted tensions, however, will make industry recognises the importance of creating a universal, creating a strong culture a big challenge for the industry resilient and pervasive culture based on integrity and mutual over the coming years. While executives champion ethical understanding. At an industry level, there is little doubt that conduct, they struggle to see the benefits of greater sincere attempts are being made at change. Industry bodies adherence to ethical standards, reporting that, in reality, are teaching non-banking staff about financial products and it can hamper career progression in the industry as well as client needs, and bankers about ethics. And many big banks the firm’s competitiveness. Also, few see knowledge of other have launched large-scale exercises to identify and mend their departments and functions as crucial to improving their culture and practices to avoid the scandals that have continued everyday performance, even though a lack of communication to erupt since the crisis. and understanding between functions is often quoted as a factor of the financial crisis. Both our survey and our interviews indicate the industry has the willingness to change. There is a widespread belief in the The pressures firms faced before the global financial crisis— importance of ethics among financial services employees, with such as quarterly reporting requirements and pleasing short- both anecdotal and quantitative evidence of steps being taken term investors—will not go away anytime soon. But it is clear to improve adherence to ethical standards. Executives also that the financial services industry is trying to mend its ways. report a basic level of understanding of the industry among The key will be to overcome the basic tensions that continue employees at all levels. They feel prepared for their current to riddle the industry, and over time see whether the top role, and see learning about issues that are relevant to their echelons are doing enough to foster a strong, risk-proof and everyday job as a priority to improve performance. Finally, client-serving culture at their firms. they recognise how a stronger adherence to ethical standards and greater knowledge can be beneficial to their firm’s ability to withstand risk.

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Appendix

The Economist Intelligence Unit conducted a Please note that not all answers add up to 100%, global survey of 382 financial services executives either owing to rounding or because respondents and 50 executives from firms that support the were able to provide multiple answers to some financial services in September 2013. Our sincere questions. thanks go to all those who took part in the The following charts represent responses from survey. financial services executives only.

In which of the following industries, if any, do you work? (% respondents)

Asset management 18 Commercial banking 16 Retail banking 15 Insurance/reinsurance 12 Private banking 11 Fund management 11 Investment banking 9 Wealth management 8

19 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

What are your firm's annual global revenues in US dollars? (% respondents)

US$10bn or more 17 US$5bn to US$10bn 7 US$1bn to US$5bn 15 US$500m to US$1bn 12 US$250m to US$500m 19 US$100m to US$250m 25 US$50m to US$100m 2 Less than US$50m 4

Which of the following best describes your firm's total assets under management? (% respondents)

Greater than US$500bn 9 Between US$250bn and US$500bn 6 Between US$100bn and US$250bn 7 Between US$50bn and US$100bn 7 Between US$10bn and US$50bn 19 Between US$1bn and US$10bn 27 Between US$500m and US$1bn 16 Between US$100m and US$500m 8 Less than US$100m 0 Not applicable/I don't know 1

Rate the financial services industry’s current reputation for ethical conduct on a scale of 1 to 5, where 1 is Poor and 5 is Excellent (% respondents) 1 Poor 2 3 Neutral 4 5 Excellent Your personal view 3 11 27 45 14 Among external stakeholders 7 15 34 37 7 Among employees 1 7 44 38 9

20 © The Economist Intelligence Unit Limited 2013 A crisis of culture Valuing ethics and knowledge in financial services

Compared to the rest of your industry, how would you describe your firm’s current reputation for ethical conduct? (% respondents) Worse About the same Better I don’t know Your personal view 3 26 71 Among external stakeholders 4 42 54 Among those in the industry 2 53 44 1

What steps, if any, has your firm taken over the last three years to improve employees' adherence to ethical standards across the firm? Select all that apply (% respondents)

Raised awareness of the importance of ethical conduct by all employees 67 Introduced or strengthened a formal code for ethical conduct 63 Introduced or strengthened the system for evaluating employee conduct 61 Introduced financial or career incentives 43 Other 1 My firm has taken no steps to improve adherence to ethical standards 1

Which of the following would benefit the most by an improvement in the ethical conduct of employees at your firm? (% respondents)

Firm's ability to withstand unexpected and dramatic risks 56 Firm's revenue and market share 30 Firm's profitability 7 Other 3 There would be no benefit 3

To what extent do you agree or disagree with the following statements? (% respondents) Strongly disagree Disagree Agree Strongly agree I don’t know Ethical conduct is as important as achieving financial success at my firm 2 6 59 33 1 The ethical standards that my firm claims to uphold publicly are the same as employees are expected to follow in practice 1 6 56 38 I would prefer to work for a firm that has a good reputation for ethical conduct than for a bigger or more profitable firm with questionable ethical standards 2 2 41 55 1 It is not realistic for everyone working in the financial services industry to adhere to ethical standards at all times 10 41 42 7 It is difficult to make career progression at my firm without being flexible on ethical standards 12 34 46 7 1 Being too rigid over ethical standards will make my firm less competitive 8 39 45 8 1 In the financial services industry, it is more important to ensure business practices are legal rather than ethical 13 55 25 7 1 Aspiring to a globally recognised set of ethical standards would make the financial services industry more resilient 2 6 60 31 2

How would you describe your firm's performance in doing the following over the next two years? Rate on a scale of 1 to 5, where 1 is Poor and 5 is Excellent (% respondents) 1 Poor 2 3 Neutral 4 5 Excellent I don’t know Maintaining highest ethical standards in the pursuit of business goals 2 5 34 44 15 Putting clients' interest ahead of self-interest 2 3 26 53 18 Promoting mutual understanding among employees across all levels and functions in the firm 3 3 28 51 14 Investing in the training and education of employees 2 5 34 47 111

How confident, if at all, are you that if you take action against or report unethical behaviour by any of your colleagues you will have the firm's full support? Rate on a scale of 1 to 5 where 1 is Not at all confident and 5 is Very confident (% respondents)

Not at all confident 3 (2) 3 Neutral 28 (4) 40 Very confident 25

Improvement in which of the following among your firm's employees is currently the most important priority for your firm? (% respondents)

Understanding of your firm's business goals and values 35 Managing client relationships 31 Technical knowledge of their own function 20 Internal communication with and understanding of other departments and functions 10 Understanding of how the finance industry as a whole works 4

In your opinion, improvement in which of the following among your firm's employees is most likely to lead to better financial performance? (% respondents)

Managing client relationships 33 Understanding of your firm's business goals and values 26 Technical knowledge of their own function 24 Internal communication with and understanding of other departments and functions 10 Understanding of how the finance industry as a whole works 6 Other 1 None of the above 1

Which of the following is the most helpful to your ability to perform your role? (% respondents) The most helpful The least helpful Knowledge of your firm's products and services 18 30 Knowledge of your firm's strategic objectives and performance 38 7 Knowledge of risks affecting your firm 31 11 Knowledge of role and performance of different departments within the firm 13 52

Which of the following is the most helpful to your ability to perform your role? (% respondents) The most helpful The least helpful Knowledge of how the industry works 17 28 Knowledge of competitive landscape 17 20 Knowledge of regulatory landscape 11 30 Knowledge of economic environment 19 15 Knowledge of risks affecting financial services industry 37 7

To what extent do you agree or disagree that your previous knowledge and experience have prepared you fully for your current position? (% respondents)

Strongly disagree 1 Disagree 2 Agree 41 Strongly agree 56 I don’t know 1

Which of the following, if any, is currently a priority for you to perform better in your role? (% respondents)

To improve knowledge of issues directly relevant to my own role 66 To improve knowledge of issues concerning other functions within the firm 23 To improve knowledge of the industry as a whole 11

Which of the following do you think would help you the most in advancing your career in the financial services industry? (% respondents)

To improve knowledge of issues directly relevant to my own role 22 To improve knowledge of issues concerning other functions within the firm 41 To improve knowledge of the industry as a whole 37

Which of the following do you think would help the most in improving the resilience of your firm? (% respondents)

To improve knowledge of issues directly relevant to my own role 8 To improve knowledge of issues concerning other functions within the firm 32 To improve knowledge of the industry as a whole 59 Other (please specify) 1

To what extent do you agree or disagree with the following statements? (% respondents) Strongly disagree Disagree Agree Strongly agree I don’t know Employees across all levels in my firm share a basic common understanding of how the financial services industry works 2 20 60 18 Employees across all levels in my firm share a basic common understanding of regulation affecting the financial services industry 3 14 60 22 1 Employees across all levels in my firm share a basic common understanding of the risks facing the firm 3 26 60 11

In your own opinion, which of the following factors makes it most crucial for those working in or serving the financial services industry to improve or update their knowledge of the industry? Select up to three options (% respondents)

Increasingly complex risk environment 50 Increasing role of technology and automation in finance 42 Globalisation of financial services 39 Specialisation of job skills 31 Customer dissatisfaction 25 Cultural differences between different countries/markets 24 Growth of outsourced services 19 Negative public image of financial services industry 15 Avoiding high profile scandals 11

To what extent do you agree or disagree with the following statements? (% respondents) Strongly disagree Disagree Agree Strongly agree I don’t know Gaps in employees' knowledge is a significant risk for my firm 6 33 50 11 1 Most employees at my firm know very little of what goes in departments other than their own 3 35 53 9

Under each column indicate whether you are confident in your knowledge of the following (% respondents) In the country I am located In the region I am located In the world Competitive landscape for my firm 88 45 14 Regulatory environment for the financial services industry 89 41 12

Which of the following best describes your job title? (% respondents)

CFO/Treasurer/Comptroller 18 VP/Director 17 Divisional president or head 14 Manager 9 Regional president or head 8 Chief risk officer 6 Chief investment officer 5 CEO/President/Managing director 5 CIO/Technology director 4 Chief operating officer 3 Other C-level executive 3 Chief of human resources 2 Board member 2 Chief marketing officer 2 Other senior executive 2

In which country are you personally located? (% respondents)

United States of America 12 United Kingdom 11 Australia 8 Switzerland 8 India 8 Canada 8 Hong Kong 8 Germany 7 China 6 Mexico 2 South Africa 2 Italy 2 France 2 Singapore 2 Denmark 1 Finland 1 Netherlands 1 Spain 1 Sweden 1 Belgium 1 Malaysia 1 Portugal 1 Austria 1 Czech Republic 1 Iceland 1 Norway 1 Russia 1 Thailand 1 Turkey 1 Other 4

In which of the following regions does your firm operate? Select all that apply (% respondents)

Europe 61 Asia Pacific 58 North America 44 Middle East 22 Latin America 21 Africa 15

In which region are you personally located? (% respondents)

Western Europe 40 Asia-Pacific 34 North America 20 Latin America 2 Middle East and Africa 2 Eastern Europe 2

In approximately how many countries does your firm operate? (% respondents)

1 37 2 – 5 28 6 – 10 13 11 – 15 4 16 – 20 2 21 – 25 3 26 – 30 3 31 + 10

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